How can we restore faith in Britain’s banks?

5th July 2012

It was billed as Bob Diamond vs the Treasury Select Committee. Who won the big match that faced the former Barclays boss against the finest parliamentary minds?

More importantly, what did the confrontation – or perhaps friendly chat, according to the committee's detractors – say to investors and the world about banking in general and the City of London in particular? And is there anything that can be done?

Those who have seen a fair few of previous Treasury Select committee meetings reckoned Diamond's three hour plus grilling was a one-off.

First name terms and I love Barclays

No one else have ever addressed all the MPs by first names – from the soft questioning Conservative Jesse Norman, a former Barclays Capital colleague – to the

aggressive Labour MP John Mann who accused him of being "either complicit, grossly negligent or grossly incompetent." And no one else has ever said he "loved" Barclays (and its 140,000 wonderful employees) so much, so often that the MPs lost patience with the phrase.

Diamond scored the early points – helped by soft questioning on the so-called Tucker phone call during the 2008 crisis which the bank published in an attempt to spread the rate-rigging blame to the Bank of England as well as other banks.

But the committee came back strongly, moving the debate to 2005 when traders asked Libor rate-setters to push the interest level higher to give them a dealing advantage. Here, Diamond was on weaker ground.

Rate rigging requests shouted across trading floors

He failed to explain how traders shouting requests across a dealing room could keep their rate-rigging secret and Diamond repeatedly blamed it all on the standby of all firms caught out – the rogue trader. In this case, there were 14 but apparently no one knew. Diamond was unclear whether the 14 had pocketed all the profits as bonuses or if the bank itself had gained.

In any case, it was so blatant that former Barclays traders would phone from their new jobs with rate-rigging requests. Where was management? Where was compliance? And given that Libor fiddling had been examined by academics and then reported in the Wall Street Journal, Bloomberg and elsewhere some three years ago, how come neither Diamond nor anyone else senior in the bank thought to look at their own staff?

The parallel Diamond universe

As Conservative MP Andrea Leadsom told him: "You live in a parallel universe." There were 173 rate-rigging requests.

It all sounded like a tale of conflict of interests, staff looking after their mates, and a lack of integrity. Or as Labour MP John Mann put it to Diamond: "Either you're complicit, or grossly negligent or grossly incompetent. You see nothing. You're in charge, you earn £20m and you are not even asking questions."

The select committee format is never great for forensic examinations, but while Diamond tried hard, the committee did better, even if it went to extra time and an England vs Italy penalty shoot-out.

Diamond is probably now thinking of retiring to his fortune – he's 60. But for the City, the nightmare continues. Trust and confidence are out of the window. Whether someone is a small borrower or major investor, they can no longer believe that they will be treated fairly. One MP even rubbed it all in with a big list of the bank's regulatory fines and court defeats.

London's financial probity in pieces

And Diamond's attempts to spread the blame more widely – doubtlessly justifiable – will have done nothing to save London's reputation as a financial centre.

"The damage to the City of London of the revelations of manipulation in the London Libor interbank market cannot be overestimated. The City is the global centre of foreign exchange trading (37% of global turnover), the home of the money markets and half of the $650 trillion global over-the-counter derivatives market. LIBOR is the benchmark interest rate on which these transactions are priced, as well corporate loans and even mortgages. According to the IMF's Article IV Spillover Report the UK's dominance in finance is reinforced by its "robust" market infrastructure, including the setting of LIBOR – the global benchmark interest rate."

He adds: "While the media is transfixed by whose head will roll, many of the substantive issues around the micro-structure of key funding markets have in fact been known for a long time. Indeed, the real surprise is that the institutions responsible for overseeing financial stability – the Treasury, Bank of England and the Financial Services Authority – and those charged with reforming the banking sector continue to permit patently fragile structures in key funding markets. This tolerance probably reflects the persistent ideology that financial markets are somehow efficient and so the structure is best devised and operated by those who use them. If there is a silver lining from these revelations it is that plans to reform the financial sector are still on the drawing board: there is still time to reconsider."

He sees this as "essentially a watered-down version of the Independent Commission on Banking (the Vickers report) recommendations.

But he warns "Neither report contains any discussion of the structure of the markets which banks use to fund themselves. It is as if banking stability can be achieved irrespective of how well the markets in which banks fund themselves function. Indeed, the fact that in modern banks asset allocation decisions are taken simultaneously with funding decisions seems to have escaped all notice. It is impossible to have a stable banking sector if the funding markets on which they depend are fragile, let alone subject to manipulation."

Some months ago he concluded: "There will only be a real reduction in excessive risk taking when (a) the incentives of those working in the industry change, and (b) the social cost of poorly functioning wholesale and shadow banking markets are addressed'.

But since this assessment was published, bonuses awarded to the heads of universal banks have increased, even as it has become apparent that the most important wholesale capital market has been manipulated. Neither concern is even mentioned in the Government's White Paper or the ICB's interim and final reports.

Financial stability will require a much more comprehensive set of reform proposals than currently exist.

It will also need banks realising they are the problem – and judging by Diamond's performance before the Select Committee, they are still as far from that admission as ever.